At that point our psyches were screeching like fingernails down a blackboard as the major world equity markets slid into bear market territory1. The bounce back since then has made our portfolio more money in one year than we managed in the previous five.

Here’s a walk through the sunny side:

We’re up 46% since starting six years ago.

That’s 11.4% annualised, or around a 9% real return – far higher than the historical average of 5% we might expect from a 100% equity portfolio. Happy times.

By way of comparison, our portfolio’s real return was about 4% annualised when we took a snapshot this time last year.

Here’s the portfolio latest in TruColor spreadsheet-o-vision:

Our 2016 barnstormers were our riskiest asset classes:

Emerging Markets up 36% (after plunging similarly over the previous two years)

Global Small Cap up 34%

Meanwhile our ‘worst’ performers in 2016 were…

FTSE All-Share up 16%

UK Gilts up 11%

…although as you can see, even our rearguard has been tremendous. Despite the fear and loathing rippling across the political spectrum, every asset class surfed the wave higher.

Our biggest holding – the Developed World excluding the UK – put on 29%.

Sure, that’s a performance buoyed by the pound tumbling against other major currencies, so our gain has been bought at the price of national impoverishment. But at least it means your financial votes count even if you feel your actual one didn’t.

Hedging against massive national gambles is a side-benefit of global portfolio ownership that I didn’t fully appreciate when I began investing.

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £900 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

It’s interesting to reflect on how difficult it was to feel enthusiastic about any asset in 2016, with so much negative press sluicing through our news feeds, yet:

I’m running through all this not to sound triumphalist, but to emphasise how disconnected results can be from the flow of media bilge lapping against our brains.

Forget trying to predict what’s going to happen next. Stick instead to a sound asset allocation strategy that will see you through thick and thin.

We kept buying on the cheap through the 2015–16 mini-bear and made out like bandits as the market recovered and soared.

It’s become very noticeable that we’re picking up fewer and fewer units for every purchase as the market tear continues. That’s why future downturns are not to be feared by accumulators. The more shares you can pick up when the market is lower, the better your gains when the recovery comes.

Portfolio maintenance

Okay, it’s time for the portfolio’s annual service. The underlying asset allocation is built on sound principles – except I’ve come to question the role of index-linked gilts (also known as linkers).

Our inflation-resistant bonds haven’t done the portfolio any harm so far. In fact they have made 22% since we bought them. But their role in our portfolio is to ward off unexpected inflation, and that’s where the linker story starts to unravel.

We’ve posted the lengthy version of my thinking previously. But in short, UK linker funds are stuffed with long-term bonds that are highly sensitive to real interest rate rises.

That potentially makes our linker fund a source of volatility rather than stability. Moreover, a number of experts believe that UK linkers’ inflation protection could be overwhelmed by their exposure to real interest rates.

Linkers still have diversification value though – and experts can be wrong. Considering all this, I’m going cut the portfolio’s linker exposure down to a 6% holding, or around 20% of our bond allocation.

I did consider adding global index-linked bonds as an alternative. They would add more diversification and less interest rate risk, in exchange for a lower likely correlation with UK inflation.

But I’ve decided against introducing extra complexity at this stage. We’ll rely on equities and property to keep us ahead of inflation over the long-term and look into more short-term conventional bond funds as our model portfolio’s time horizon ticks down.2

My, how we’ve grown

Another light winking on the portfolio dashboard is that we’ve heading out of percentage-fee broker territory.

Our portfolio is notionally held in an ISA with Charles Stanley who charge an annual 0.25% of assets. That’s around £80 a year on our current value.

A flat-fee broker, in contrast, would levy a fixed cost regardless of our portfolio’s size. They’d also add dealing charges on top.

Right now there’s little in it either way for us. But as our portfolio swells (hopefully!) then the percentage-fee will swell too. By comparison, the flat-fee alternatives will look increasingly cheap and therefore more alluring! We’ll need to consider a switch.

It’s not worth us doing anything too hasty – broker charges can change, as can portfolio values – but I’ll need to address it at some point over the next year.

Or not, if the market crashes.

Buying more bonds

We’re also committed to shifting 2% from equities to government bonds every year. This risk management move gradually curbs our exposure to stock market crashes as our time horizon shortens.

We’re now 68:32 in favour of equities versus bonds, with 14-years left on the clock. The 2% equities cutback comes from our UK fund, as part of our ongoing move away from the home bias we originally built into our allocation.

This change, plus the reduction in our holding of linkers, lifts our conventional government bond allocation by 11% to 26%. We’ll likely be glad of this if the market takes a dive in 2017.

Increasing our quarterly savings

Accursedinflation is next on our list.

If we want to invest a consistent amount every year then we must beware of inflation eroding our cash like water against a rock.

The last RPI inflation report was 2.2%. That means we need to increase our £880 quarterly contribution in 2016 pounds to £900 in 2017.

Rebalancing act

Every year we rebalance the portfolio back to its target asset allocations. Again this is primarily about risk management as we automatically make slight course corrections away from assets that have soared in value recently in favour of those that are now on sale.

The upshot of this rebalancing back to our (predetermined) asset allocations is we’ll be putting a lot of money into bonds – less risky assets – and a tiny smidge into global property, which fell back a little last quarter.

We sell down a portion of our other five funds and throw in our new quarterly cash contribution to fund the rebalance.

Remember, we’re not making a judgement call here. We’re just staying in line with the asset allocation we have set.

Incoming!

Q4 was income jackpot time for our funds. They paid out £387.89 in dividends and interest, which is automatically reinvested thanks to our accumulation funds.

Here’s our income scores:

UK equities: £78.52

Developed world equities: £209.99

Global small cap equities: £7.06

Emerging markets equities: £51.76

Global property: £24.61

UK Government bond index: £15.96

Total dividends: £387.89.

As I say, this isn’t new money we have to invest. It is automatically been rolled up by the accumulation funds.

I just think it’s motivating to see this hidden income being accrued by our funds.

New transactions

Every quarter in 2017 we will slot another £900 into the market’s fruit machine. Our cash is divided between our seven funds according to our (freshly tweaked) asset allocation:

This model portfolio is notionally held with Charles Stanley Direct. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.

Take a look at our online broker table for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000.

Average portfolio OCF = 0.17%

If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,The Accumulator

Thanks for reading! Monevator is a simply spiffing blog about making, saving, and investing money. Please do check out some of the best articles or follow our posts via Facebook, Twitter, email or RSS.

Yes, my enthusiasm for not following the stampeding herd may have given the impression I was being a bit gung-ho. The rebalancing you refer to is of course exactly the solution. I guess the only issue is as someone with a high risk tolerance right now I would lean to going for a 100% equities portfolio to maximise long term returns and so holding bonds feels like it would reduce my ambition. But maybe that’s the point. I see how bonds actually boost long term returns during volatile markets.

But in that case I wonder, what’s the most aggressive ratio of bonds to equities in volatile market conditions?

@Joe — Welcome to the site, and to investing. Nothing you’re suggesting hasn’t been thrashed out a million times over the markets over the past 100 years, and there are trillions of dollars betting one way or another right this instant, by teams of quants running supercomputers and/or hooked up milliseconds away from price flows. You might wonder in this context what your edge is, and if you haven’t got one invest passively.

Sometimes tilting actively works, sometimes it doesn’t. I invest actively but “with my eyes wide open” would be an understatement. 🙂 Most people will do better to invest passively and get on with their lives (and their careers) rather than trying to be cute.

This article might be of interest as you weigh up potential opportunity cost (aka the risk of missing out on further equity rises) versus downside risk:

@TheInvestor – Thanks for the info. Yes, I’ve long thought how I can’t compete against the massive resources of the hedge funds so the discovery of passive investing and effectively harnessing the power of The Borg-like, hive mind has been a revelation. Seriously, huge thanks for creating such an engaging online resource.

I certainly have no ‘edge’ in terms of knowledge or skill, the only edge is in what I need compared to them. Many of them need quicker returns whereas I do not. So if I can use my lack of need for short term returns in exchange for longer term ones then it seems sensible to try to do so.

A very closely related concept also shows up in investing via a debated ‘factor‘ called the illiquidity premium.

Keep in mind money might not be as desperate for short-term returns as you may think, though. For instance most passive equity money stayed invested through the financial crisis; it’s marginal sellers that set prices.

I have a question about buying a fund of gilts or bonds. I wonder why does the Slow and Steady Portfolio have UK gilts/bonds rather than global? If we’re tracking the global equities market as a whole would it not be wiser to hedge the risk of the global market by having global bonds?

I’m currently using the L&G International Index Trust ex UK (0.13%) plus the Blackrock UK Equity (0.06%) to track the global market as a whole. I’m assuming the automatic market rebalancing within the L&G fund, plus my manual rebalancing of UK vs world means I’m set up to benefit from any changes between regional markets? But in order to benefit from rebalancing between the global market volatility and bonds/gilts should I have access to global bonds/gilts rather than just UK? Thanks.

Hi Joe
I could never understand why one would globally diversify ones equities and not ones bonds.
Seems logical to do both
I have nearly finished transferring my short term gilt ladder into the Vanguard Global GBP Hedged Index fund
Taken about 5 years and done as each Gilt matured
Worked well for me-fund has performed well-better than the Gilts
xxd09

@malcolm Beaton @joe. It’s about currency risk. International bonds give more diversification obviously but also a lot of exposure to currency risk. The cost of hedging was probably prohibitive in the past but global bond funds hedged to sterling are available now. Vanguard do one and maybe other companies do too. There is an excellent not too technical paper from Vanguard type “going global with bonds considerations for uk investors vanguard” into Google and it should come up.

I’m following the S&S with great interest, half my sipp in VLS60 and i would align with S&S but for (for me) the thorny question of how to adjust asset allocation as closer to retirement date. Inspired but not quite baked yet.
So question is , with S&S 14 years to go , does that mean that at presently 68/32 , with a 2% adjustment each year , S&S ends at 40/60 Equity bonds ?
ie is that when the notional drawdown starts, or state pension age reached , assume it’s not for an annuity…..or is it simply a time when no further contributions likely, and accordingly set to preserve rather than grow
Of course i’m trying to relate this to my situation, 8 years from SP age, and 5 from whence a modest DB scheme kicks in. i’ve read the articles , deducted my age from various numbers , and seem to keep going around in circles when it comes to a suitable asset allocation as retirement approaches. Also, and i’m assuming it will be at least 50% in bonds, given the recent comments on limiting index-linked Gilts, whether to start to include Global bonds (in GBP) now ? Will certainly be watching closely on whether TA includes Global bonds in later updates.
Really appreciate all your efforts…

Hi hyperhypo
Difficult isn’t it!
However some thoughts from someone down the line-13 years into retirement.
A portfolio of 70-30 % equities balanced by 70-30% bonds give a probable 4% return.
Your income from your portfolio at all times will be roughly this-ie save as much as you can!
A rough guide is your age should be % of bonds in your portfolio
Once you have made enough -stick at a minimum of 30% bonds-age 70.
Worked and is working for me-now 71
xxd09

Please could you clarify your comment…I’m afraid I’ve not entirely understood your point. Are you implying that at age 71 your folio is set at 71% bonds / 29% equities …I didn’t understand what you were getting at by ” portfolio of 70-30 % equities balanced by 70-30% bonds give a probable 4% return”…..and I didn’t get what you meant by “stick at a minimum of 30% bonds-age 70”.
Thank You ! I can certainly see where the 50/50 lazy folio advocate was coming from now …

Dear Mr Monevator, thank you for turning economics and investment into a language that I can understand. You have helped me immensely. Thanks for making economics interesting and relatively easy to understand.

Hi Hyperhypo
Sorry for lack of clarity-it’s a big subject for one post
Yes -aim for you age in bonds .70 year old 70% bonds.
30 year old -30% bonds
General rule-younger more equities-older less equities
Equities are the “risk” part of the portfolio but the area where you make gains
Yes-a portfolio constructed this way would generate at least 4% return-use 4% figure to estimate your eventual withdrawals at retirement.
Yes-it is generally considered unnecessary (and probably unsafe)to go below 30% bonds in a portfolio to get best returns
These are 3 General rules to use only as a guide
There are more-this website is a good source of material and information
xxd09

Dear Monevator,
Long time listener, first time caller. I have been working on my passive portfolio for 2 years inspired by your blog (although mine has a Euro slant since I invest in Luxembourg). So all the funds you have selected are accumulators? 5 of my 8 funds pay out dividends back into my trading account. I know I should reinvest this money, but how best to do it cost-effectively, since I pay €25 per trade? Similar problem with rebalancing, it would take a few separate trades to rebalance, and maybe it would add up to €75 or even €100 in trading costs.
Thanks for your insights over the years – love the blog.

Spent the better part of the weekend reading all of the articles in the Passive Investing section of the website, and wanted to thank you for the helpful information presented in a way I can almost understand 🙂

I’ve been meaning to move my cash ISA pot into a stocks & shares ISA for a few years but just haven’t had the confidence to make the jump; worried that I would may poor choices and lose it all. One nagging question at the back of my mind is this: is NOW the wrong time to invest? I’m trying to feel buoyed by the idea that “time in the market” is better than “timing the market”, but after seeing the spectacular gains made last year, is this a relatively expensive time to start investing?

@Ben — Only you can decide that for yourself. We generally think that most investors will do better to stick to a long-term plan and not make such calls, which on balance will hurt more than they help. These articles (and the comments that follow them) may be of interest:

Hello – regarding the Vanguard Life Strategy series. I read on a forum the following critique made of the Funds. I am am wondering what the thoughts are of of resident expert/s:

“- The VLS fund for example is in a pigeon hole where its apparent “competitors” may have a fixed or variable equity component going up to 85% at very top end. VLS80 is permanently no less than 80%. It has pretty much the highest equity component in its “mini-league”. In an equity bull run it will do awesome. In an equity crash it will be terrible and other end of the league

-VLS fund has 75% of its equities overseas and its UK equities are majority FTSE100 with high dollar revenues. That is a higher overseas equity and foreign currency component than most UK investors accept, so it is higher risk from that perspective and in sterling weakness it will do awesome but in sterling strengthening it would be poor and other end of the league

– VLS non equity component is 100% bonds while other things in the mini league will use a mixture of bonds, real estate maybe a bit of gold or other commodities or multi-strategy solutions like currency plays or whatever. Some rivals are pure equity/bond, but many aren’t. As we mentioned, bonds have been on a 30 year bull run until last year. So when you pull up a chart for five years, the VLS non-equity component did nicely thanks to the bull run, and maybe better than the other competitors in the mini league whose non equities bit on average had a broader mix of some bonds, some “other non-equities”. As such, VLS did well but if bonds fall next to other non-equities it will push them towards other ends of the table.

Basically, VLS as a product range was well positioned for the specific set of circumstances we experienced since VLS launch in July 2011. It tops the table in the widely-drawn mixed asset categories and people recommend it.

There is a risk that some investors think that because it topped the table in the good years it will be better at surviving the bad years because the reason it topped the table was due to vanguard being competent, reliable and cheap. Ok cheap is a part of it. But instead the performance was really due to how the static asset mix was positioned. It pushed them right to one end of the table. Opposite economic circumstances could push them right to the other.”

@Percy — I don’t think that’s a criticism of the LifeStrategy funds so much as (potentially) a criticism of the people using them. Around here we think most people are best off getting a mix of *global* equities and bonds, as cheaply as possibly, with allocations adjusted to suit your risk tolerance. The LifeStrategy funds give you that cheaply and easily. But of course if global stock markets crash they’ll fall too.

The currency/sterling issue potentially more relevant than usual due to political factors. I discussed this recently here:

Hi Investor – thank you very much indeed for your reply. I appreciate your time. So other than the currency/sterling issue, you see no reason to think that VLS will perform worse than it’s rivals in a downturn?

@Percy — Hi again. It’s a tracker fund, it will do what its mix of assets/markets do, minus its low costs. Its mix of assets are transparent, so you can have a look and take a view (or do what most passive investors eventually do, which is try *not* to have a view).

Hard to gauge your level of reading up on all this, but a good place to start is here:

Hi Percy, the critique is effectively like criticising a dog for not being a cat or a kettle for not being a toaster. It isn’t all things to all men but it is a straightforward, globally diversified fund that can be expected to deliver reasonable returns over the long term at low cost.

For my money, it is a positive that its equity and bond components are fixed. That means I have a reasonable idea of how suitable it is for me without paying over the odds for some fund manager to keep fiddling with the asset allocation on the pretence that they can forecast the future. If you’re worried about an equity crash then VLS 60 or 40 could be a better solution.

This line: ‘higher overseas equity and foreign currency component than most UK investors accept’ implies there’s a problem with a globally diversified portfolio. Most UK investors are over-allocated to the UK because of a common behavioural quirk called home bias. It’s a version of the familiarity bias – we’re drawn to things we know well. That’s a weakness not a strength. A home bias makes sense for retirees or near retirees but not for most other investors.

Equities and bonds are the best combination of assets available. The others mentioned are either unnecessary or of uncertain or marginal worth. Equities generally provide growth, bonds generally provide a measure of safety in a crash. They are complementary assets. Beware: no asset works in every situation, or as advertised, all the time.

Finally, VLS is a good fund because it is simple, cheap and offers a diversified asset allocation without getting bogged down in the exotic or esoteric. It has performed well over the last few years but that’s not why I think it’s good. I don’t know if the author of the critique meant to imply that the fund was somehow only fit for a narrow range of circumstances, or somehow designed to capitalise on the trends of the last 6 years, but that’s not the case.

When global equities underperform then the fund will underperform. Historically, equities have been the most reliable driver of returns over most periods.

VLS 60 is 60% equities, which is probably a better balance for most people, especially if they don’t know what their risk tolerance is.

Hopefully you’ll get a chance to browse through the links The Investor recommends. Useful books that will also help:

Hi Accumulator – thank you very much indeed for that explanation. I very much appreciate you taking the time to do that. I’m fairly new to investing, having started in November of last year (and reading this site for much/most of my learning, so thank you very much for all of your hard work on this brilliant site).

Yes, that was my impression of the VLS products. I think if someone told you that they had purchased the components of VLS separately (as happens pretty much on your ‘Slow and Steady’ case study) then you’d say that it was a very sensible choice. So I see no reason to think that simply buying VLS isn’t also a very sensible choice.

I guess we won’t know how VLS, and therefore it’s choice of equities and bonds, performs in a crash until the crash actually happens. And as you say, a crash will lower all ships, not just VLS.

Thank you very much for all the links, which I will be reading over the weekend (and have indeed read a few).